Figure 5 reflects Vanguard’s assessment of whether monetary policy is stimulative or tight. The higher the line, the tighter the conditions, which you tend to see if inflation is out of control and the labor market is already at full employment. The shaded areas represent recessions. The COVID-19 recession was deep, but it was so short that it barely registers on the chart. You can see how stimulative that monetary policy was—appropriately so—during the recovery from the global financial crisis. But monetary policy is more stimulative today than it was during the global financial crisis, and this isn’t a debt-deleveraging recovery. This chart doesn’t reflect fiscal policy, but if it did, we’d need another floor.
Policymakers have been extremely successful in arresting a horrible shock. It’s a reason many companies didn’t go under. In one sense it was a heroic effort. But the critic in me says: Be careful of fighting the last war. If we wait too long to normalize, we're going to have another issue on our hands, the potential for strong wage growth to fuel more persistent inflation. If we get past the supply chain issues, which I think we will, the Fed will have to be adept. It should not raise interest rates now in the face of a profound supply shock. But when those conditions are ameliorated, the Fed will need to have the conviction to raise rates in an environment where the inflation rate may be coming down and the labor market continues to tighten.
The time of 0% interest rates should soon come to an end. That will help keep the growing risks of more permanent inflation at bay.
I’d like to thank Vanguard Americas chief economist Roger Aliaga-Díaz, Ph.D., and the Vanguard global economics team for their invaluable contributions to this commentary.